The past ten months have been particularly beneficial for active managers, and so it is no surprise that pension funds today have a more favourable view of the fees they pay for actively-run mandates. In addition, more pension funds today have succeeded in negotiating lower management fees following a particularly difficult period for markets in 2008. The findings are consistent with the results of our first fee survey in the winter of 2008 and 2009 when the financial crisis was in full swing and pension funds were highly critical of active strategies and their associated fees. At the time, 20% of pension funds who responded to our survey believed they received either very poor or poor value for money for their investment in a FoHF. Another 13% said they received fair value and only 10% reported getting good value, with 57% not having any exposure to FoHFs.

Today, a higher number of pension funds have eschewed FoHFs, with 67% of respondents noting that they have no exposure to the asset class, an increase of 10% from our last survey. Of those who do have exposure, sentiment has improved visibly in response to our query to consider their management fees and then rate them as very good, good, fair, poor and very poor for each of 14 different asset classes and strategies. When considering management fees, only 10% of pension funds rate their FoHF investment as poor or very poor. This represents an improvement of 10% from our last survey. Eight percent say they get either very good or good value for money for their FoHF investment while 15% believe they receive fair value. Sentiment has improved toward all active strategies, not just FoHFs. Single hedge funds, active currency, long-only equity, fixed-income and Global Tactical Asset Allocation (GTAA), all received significantly higher ratings this year while passive equity fees elicited less excitement.

The improvement in sentiment is particularly striking for fees paid for active long-only equity mandates. Not one pension fund picked very poor compared to 3% who did last year. The percentage of those who picked poor, the next choice in our ranking, is also significantly lower at 13% compared to 23% last year. Another 8% of pension funds rate the management fees they pay for long-only equity as very good and 38% as good compared to just 6% and 16% last year. Twenty-seven percent of respondents rate management fees for this particular asset class as fair. In addition, more pension funds have exposure to equity this year, with only 14% saying they do not invest in equity compared to 17% last year.

Research for the survey, which is the second in our series, was conducted in December 2009 and January 2010. Our questions were sent to a wide cross-section of pension funds, half of which are corporate pension schemes (51%) followed by public pension funds (27%). The 48 participating schemes have €182bn in AUM. Nineteen percent have more than €5bn in AUM and 15% between €2-5bn in AUM. Seventy percent of the respondents are in Europe and the rest are in North America. European respondents are concentrated in the UK (28%), followed by the Nordic countries (20%), Italy (6%), Germany (4%), Netherlands (4%), Austria (4%), Switzerland (2%) and Lichtenstein (2%).

As we mention above, more pension funds have negotiated lower base and performance fees in 2009. When asked if the base and performance fees they negotiated last year were lower, higher or unchanged compared to 2008, 28% of respondents say their base fees are lower compared to only 3% who say they are higher and 69% who note that they are unchanged. For performance fees, 19% note they are lower, whereas just 2% say they are higher and 79% reporting the fee structure of their managers as unchanged.    

Pension funds were also asked how recent market events are likely to impact their passive versus active portfolio holdings. Our results indicate a wholesale shift in favour of active strategies which also come with higher management costs. Twenty-three percent of pension funds have moved or intend to move toward active equity mandates while only 19% will favour passive ones and 58% reporting no change. The shift is noteworthy as only 9% of pension schemes tilted toward active equity strategies last year while a higher percentage (28%) favoured more passive mandates with 63% reporting no change.

The second section of our pension fund fee survey focuses on liquidity issues. We ask if pension funds are willing to agree to different lock up regimes in exchange for lower management fees and solicit their views on various incentive fee structures over a period of time as a function of realised profits. The priority for investors this year remains lowering base fees while lowering performance fees have receded in importance. Asked which of the following they are more likely to negotiate with their asset managers: a lower base fee, lower performance fee, a higher hurdle rate, a longer period of calculation for performance fee, higher water mark or lower other costs, 66% of pension funds report their preference is to reduce base fees compared to 60% last year. The second most selected preference is lowering performance fees. Fifteen percent want to do so, compared to 20% in our first survey. Nine percent would like to negotiate a higher hurdle rate, 6% a longer period of calculation for performance fees, 2% a higher water mark and 2% lowering other costs.

After enduring a long period of market volatility, some funds are demanding that performance fees be calculated over a longer period. Asked what time period they would like their performance fees to be calculated over, 23% believe over a four-year period and 23% over a five-year period compared to only 13% and 16% last year. Another 24% want performance fees to be calculated over two-years and only 15% over one-year with 15% not responding.  In other findings, nearly half (44%) are not prepared to concede to a lock up in exchange for lower fees. Twenty-six percent are prepared to concede to a one-year lock up, 12% for a two-year lock up and 18% for a three-year lock up. The results show that liquidity and the ability to terminate mandates quickly remain of paramount concern for schemes.

Pension funds expect different discounts in base fees for one, two and three-year lock ups. The average discount they expect for a one-year lock up is 13.6%, while for a two-year lock up it is 17.5% and for a three-year lock up it is 24.3%. “Performance fees should be calculated over the time period of the investment,” notes one respondent. “There should be a one-year time horizon for equities and fixed-income and a longer one for less liquid strategies such as real estate and private equity.” Another pension fund comments: “Since the performance of most managers is measured over a three to five period, performance fees should be aligned with the same period.”

The survey also looked at the geographic location of alternative asset managers and if this had an impact on the fees they charge. Nearly half of alternative managers (47%) are offshore or located outside the country the pension funds are based in. Asked if the fees charged by offshore managers are lower, higher or the same as their domestic ones, 20% say base fees are higher and 18% believe performance fees are higher. Only 1% report that base fees for offshore managers are lower while the overwhelming majority note no difference in the base fees (79%) and performance fees (82%) charged by their alternative manager. We asked the same question regarding hurdle rates and high watermarks. The overwhelming majority (88% for hurdle rates and 90% for high water mark) report no difference in the rates of offshore managers. Finally, survey participants report that only 37% of their alternative managers use a high water mark structure.

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